I'm a financial journalist and author with experience as a lawyer, speaker and entrepreneur. As a senior editor at Forbes, I have covered the broad range of topics that affect boomers as they approach retirement age. That means everything from financial strategies and investment scams to working and living better as we get older. My most recent book is Estate Planning Smarts -- a guide for baby boomers and their parents. If you have story ideas or tips, please e-mail me at: deborah [at] estateplanningsmarts [dot] com. You can also follow me on Twitter

My older sister best described our family’s curse when she said, “If we don’t have something to worry about, we will find something to worry about.” We not only inherited my Dad’s worry gene, but his constant harping about what could go wrong trained us well in its use.

Based on my negative predisposition you would think I never take risks, but that’s not true. It’s just that I am always weighing the expected benefits against the potential dangers. So I drive at or near the speed limit because the time saved is not worth the risk of getting a ticket. But when my oldest daughter asked for advice on whether she and her new husband should use their savings to buy a house or backpack around the world, I replied “If you don’t take the trip you will kick yourself when you are my age.” I said that because I believed the experiences they would gain were more than worth the dangers they would face.

But here’s what I’m worried about this week: With the Dow industrials approaching 13,000–a four-year high–too many people will overlook significant investment risks.

Risk management requires prudent balancing of risk and return. Assessing this balance, based on individual needs, should be the main concern when building a portfolio. But as W. Scott Simon, author of “The Prudent Investor Act: A Guide to Understanding,” observed, “Everyone talks about risk management, but very few actually do it.” Part of the problem says Simon, who has been an expert witness in lawsuits against some of the largest global financial institutions, is that both investors and investment managers regard track records as a gauge of future risk and return.

Ken French, a Professor of Finance at the Tuck School of Business at Dartmouth, compares this to a firm that has sold earthquake insurance. “The strategy may produce a long string of impressive returns before one year of losses wipes out many years of profits,” he wrote in The Squam Lake Report, a nonpartisan report to Congress that he chaired. Likewise, a trader who inadvertently develops an investment strategy is celebrated as a genius in the good years when he guesses right. But the risk is still always there.

“Many sophisticated traders and hedge fund managers were not aware of the ‘earthquake risks’ inherent in many of their strategies,” French writes. The unseen risk that was present in the good years becomes the earthquake risk that appears randomly in the bad years when markets turn and start to favor other sectors or strategies.

Because of hidden risk, track records are worthless indicators of future risks and returns. Here are five better ways to manage investment risk.

1. The solution to pollution is dilution. Investors should take a cue from environmental experts. Avoid concentrating in a stock, industry, sector, asset class or country. We all know we should diversify. Doing it by picking the things we think will do best seems to makes sense, but that’s wrong. Diversification works not because you pick winners but because you pick things that are different. So, broadly diversify within and across asset classes. Diversify stocks by size, between value and growth, and across countries.

2. Avoid low quality or longer-term bonds. There are three main categories of investments–cash, bonds, and stocks–and each one has a different purpose in your portfolio. Cash is for liquidity; bonds are for stability; and stocks are for growth. By focusing on bonds for stability instead of income, you can significantly reduce the risk in your portfolio. Therefore, bonds should be relatively short in maturity (five years or less) and high in quality. By constructing a portfolio in this manner, the balance between risk and return can more easily be adjusted based on the percentage allocation to stocks versus bonds.

3. Keep asset allocation constant. Tactical allocation changes the percentages each year to overweight in the asset classes expected to have the best returns and avoid the ones with the worst returns. It sounds good, but it’s just another futile attempt to predict the future. Keeping a constant weighting in your target asset allocation is a better long-term strategy than trying to outguess financial markets.

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